Financial risk management and financial instruments

Risk management

Introduction

The group has exposure to the following risks from its use of financial instruments: credit risk, liquidity risk and market risk (foreign exchange, interest rate and price risk). This note presents information about the group’s exposure to each of the above risks, the group’s objectives, policies and processes for measuring and managing risk, and the group’s management of capital. Further quantitative disclosures are included throughout these consolidated financial statements.

Risk profile

The group’s overall risk management programme focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on the financial performance of the group. The group considers natural hedges that may exist and, in addition, where possible, uses derivative financial instruments such as forward exchange contracts to hedge exposures. As a matter of principle, the group does not enter into derivative contracts for speculative purposes. The group applies hedge accounting to manage its risk of currency exchange rate volatility associated with certain of its investments in foreign operations.

Risk management is carried out under policies approved by the board of directors of the group and of relevant subsidiaries. The MTN Group treasury committee identifies, evaluates and hedges financial risks in cooperation with the group’s operating units. The board provides written principles for overall risk management, as well as for specific areas such as foreign exchange risk, interest rate risk, credit risk, use of derivative financial instruments, and investing cash. Group treasury is responsible for managing the group’s exposure to financial risk within the policies set by the board of directors, under the guidance of the group CFO and group board audit and risk committees.

Categories of financial instruments

Financial assets and liabilities subject to offsetting

The following table presents the group’s financial assets and liabilities that are subject to offsetting:

The amounts subject to offsetting include interconnect receivables and payables as well as sundry receivables and payables. The group has entered into agreements with the respective counterparties which permit it to offset any payables owing to the counterparty against receivables owing to the group. This right to offset exists in all circumstances and the group intends to settle on a net basis.

Fair value estimation

A number of the group’s accounting policies and disclosures require the measurement of fair values. The group uses valuation techniques that are appropriate in the circumstances and for which sufficient data are available to measure fair value, maximising the use of relevant observable inputs and minimising the use of unobservable inputs.

The table below presents the group’s assets and liabilities that are measured at fair value. The classification into different levels is based on the extent that quoted prices are used in the calculation of fair value and the levels have been defined as follows:

• level 1: fair value based on quoted prices (unadjusted) in active markets for identical assets or liabilities;
• level 2: fair value based on inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly (that is, as prices) or indirectly (that is, derived from prices); or
• level 3: fair value based on inputs for the asset or liability that are not based on observable market data (that is, unobservable inputs).

The following table presents the fair value measurement hierarchy of the group’s assets and liabilities measured at fair value:

Valuation methods and assumptions

The following methods and assumptions were used to estimate the respective fair values:
IHS unlisted equity investment – The fair value of the investment at 31 December 2016 was determined with reference to recent transactions between market participants and consequently the investment was categorised within level 2 of the fair value hierarchy. At 31 December 2017, the absence of transactions between market participants resulted in the fair value being determined using models considered to be appropriate by management. The fair value was calculated using an earnings multiple technique and was based on unobservable market inputs including tower industry earnings multiples of between 13x to 17x applied to MTN management’s estimates of earnings, less estimated net debt.

Given the confidentiality restrictions in the shareholders’ agreement with IHS Group, MTN does not have access to the IHS Group business plans or 2017 actual financial information. Any estimated earnings used to derive the existing fair value are therefore solely based on MTN management assumptions and market estimates on financial growth, currency movements, costs and performance. The investment has therefore been transferred from level 2 to level 3 of the fair value hierarchy for the current reporting period. An increase of one in the low and high end of the multiple range, keeping other inputs constant, would have resulted in an increase in the fair value of R2 148 million and a decrease of one in the low and high end of the multiple range, keeping other inputs constant, would have resulted in a decrease in the fair value by R2 148 million as at 31 December 2017. An increase of 10% in the estimated earnings used, keeping other inputs constant, would have resulted in an increase in the fair value of R3 201 million and a decrease of 10% in the estimated earnings used, keeping other inputs constant, would have resulted in a decrease in the fair value of R3 201 million as at 31 December 2017.

An increase of R4 249 million (December 2016: R2 672 million) has been recognised for the year under review in other comprehensive income resulting from the change in fair value.

Other unlisted equity investments – Fair values have been estimated using a discounted cash flow model. The discounted cash flow model requires management to make assumptions about the model inputs, including forecast cash flows, the discount rate, credit risk and volatility. The probabilities of the various estimates within the range can be reasonably assessed and are used in management’s estimate of fair value for these unquoted equity investments.

Derivatives – The group enters into derivative financial instruments with various counterparties. Interest rate swaps, foreign exchange contracts and equity derivatives are valued using valuation techniques, which employ the use of market observable inputs. The most frequently applied valuation techniques include forward pricing and swap models using present value calculations. The models incorporate various inputs including the credit quality of counterparties, foreign exchange spot and forward rates, yield curves of the respective currencies, currency basis spreads between the respective currencies and interest rate curves.

Investment in insurance cell captives – The fair value of the investment in cell captives is determined based on the net asset value of the cell captive at the reporting date. The net asset value is determined from statements received from the insurer in respect of the net assets of the cell.

Investment in treasury bills – The fair value of these investments is determined by reference to published price quotations in an active market.

Fair value measurements for financial instruments not measured at fair value

Loans and receivables and financial liabilities at amortised cost – The carrying value of current receivables and liabilities measured at amortised cost approximates their fair value.

The fair values of the majority of the non-current receivables and liabilities measured at amortised cost, other than for the instruments listed below, are also not significantly different to their carrying values.

The group has listed long-term fixed interest rate senior unsecured notes in issue which were issued in prior years, with a carrying amount of R9 297 million at 31 December 2017 (2016: R10 354 million) and a fair value of R9 284 million (2016: R9 494 million). The notes are listed on the Irish bond market and the fair values of these instruments are determined by reference to quoted prices in this market. The market for these bonds is not liquid and consequently the fair value measurement is categorised within level 2 of the fair value hierarchy.

During the 2016 year, the group issued US$1 billion listed long-term fixed interest rate unsecured notes. Notes with a face value of US$500 million are redeemable in 2022 (the 2022 notes), with the remaining US$500 million redeemable in 2026 (the 2026 notes). At 31 December 2017, the carrying amount of the 2022 notes is R6 239 million (2016: R6 849 million) and the fair value is R6 432 million (2016: R6 958 million); and the carrying amount of the 2026 notes is R6 229 million (2016: R6 856 million) and the fair value is R6 718 million (2016: R6 727 million). The notes are listed on the Irish bond market and the fair value of these instruments is determined by reference to quoted prices in this market. The market for these bonds is not considered to be liquid and consequently the fair value measurement is categorised within level 2 of the fair value hierarchy.

Reconciliation of level 3 financial assets

The table below sets out the reconciliation of financial assets that are measured at fair value based on inputs that are not based on observable market data (level 3):

Credit risk

Credit risk, or the risk of financial loss to the group due to customers or counterparties not meeting their contractual obligations, is managed through the application of credit approvals, limits and monitoring procedures.

The group’s maximum exposure to credit risk is represented by the carrying amount of the financial assets that are exposed to credit risk.

The group considers its maximum exposure per class, without taking into account any collateral and financial guarantees, to be as follows:

Cash and cash equivalents and current investments

The group determines appropriate internal credit limits for each counterparty. In determining these limits, the group considers the counterparty’s credit rating established by an accredited ratings agency and performs internal risk assessments. The group manages its exposure to a single counterparty by spreading transactions among approved financial institutions. The group treasury committee regularly reviews and monitors the group’s credit exposure.

The operations in Nigeria, Dubai and South Africa (including head office entities) hold their cash balances in financial institutions with a rating range from B- to AA- (2016: B- to AA+).

Given these credit ratings, management does not expect any counterparty to fail to meet its obligations.

Investment in cell captives

The group has exposure to the credit risk of the insurance company through its investment in preference shares in its cell captive arrangements. However, the group has access to the assets of the cell which reduces this risk.

Trade receivables

A large portion of the group’s postpaid market revenues are generated in South Africa. There are no other significant concentrations of credit risk, since the other operations within the group operate largely within the prepaid market. The group has policies in place to ensure that retail sales of products and services are made to customers with an appropriate credit history. Before credit is granted to a customer, the group performs credit risk assessments through credit bureaus. The group insures some of its trade receivables in its South African operation, in which instance the credit risk assessments are performed by the credit insurer prior to the granting of credit by the group. In terms of this arrangement, R7,9 billion has been insured for which the group’s risk is limited to R25 million. In addition, some entities within the group require potential customers to obtain guarantees from banks before credit is granted.

The recoverability of interconnect receivables in certain international operations is uncertain; however, this is actively managed within acceptable limits and has been incorporated in the assessment of an appropriate revenue recognition policy (note 2.2) and the impairment of trade receivables where applicable. In addition, in certain countries there exists a right of set-off with interconnect parties to enable collection of outstanding amounts.

Ageing and impairment analysis

Total past due per significant operation

Allowance for impairment of trade receivables

The group does not hold any collateral for trade receivables.

Liquidity risk

Liquidity risk is the risk that an entity in the group will be unable to meet its obligations as they become due.

The group’s approach to managing liquidity risk is to ensure that sufficient liquidity is available to meet its liabilities when due under both normal and stressed conditions, without incurring unacceptable losses or risking damage to the group’s reputation.

Group treasury develops strategies to ensure that the group has sufficient cash on demand or access to facilities to meet expected operational expenses, and to service financial obligations. This excludes the potential impact of extreme circumstances that cannot reasonably be predicted, such as natural disasters. Group treasury performs regular cash flow forecasts, monitors cash holdings of the group, negotiates lines of credit and sets policies for maturity profiles of loans.

The following liquid resources are available:

The group’s undrawn borrowing facilities are disclosed in note 6.1.

Although cash held by MTN Nigeria, MTN Sudan, MTN South Sudan and Areeba Guinea S.A. is available to settle liabilities denominated in the local currency in the respective country of operation, access to foreign currency in the country is constrained.

The following are the undiscounted contractual cash flows of financial liabilities:

Market risk

Market risk is the risk that changes in market prices (such as interest rates, foreign currencies and equity prices) will affect the group’s income or the value of its financial instruments. The objective of market risk management is to manage and control market risk exposures within acceptable parameters, while optimising the return.

Derivatives are entered into solely for risk management purposes and not as speculative investments. The group treasury policy specifies approved instruments which may be used to economically hedge the group’s exposure to variability in interest rates and foreign currency and to manage and maintain market risk exposures within the parameters set by the group’s board of directors.

Interest rate risk

Interest rate risk is the risk that arises on an interest-bearing asset or liability, due to variability of interest rates.

Financial assets and liabilities that are sensitive to interest rate risk are cash and cash equivalents, restricted cash, trade and other receivables/payables, loans receivable/payable, borrowings, bank overdrafts and other non-current liabilities. The interest rates applicable to these financial instruments are a combination of floating and fixed rates in line with those currently available in the market.

The group’s interest rate risk arises from the repricing of the group’s floating rate debt, incremental funding or new borrowings, the refinancing of existing borrowings and the magnitude of the cash balances which exist. The group aims to maintain its mix of fixed and floating rate debt within internally determined parameters, however, this depends on the market conditions in the geographies where the group operates.

Holding companies’ (as disclosed in note 9.1), including MTN (Mauritius) Investments Limited, debt is managed on an optimal fixed versus floating interest rate basis, in line with the approved group treasury policy.

Debt in the majority of the group’s non-South African operations is mainly at floating interest rates. This is due to the environment and availability of funding in the market in which the entity operates. The group continues to monitor developments which may create opportunities as these markets evolve in order to align each underlying operation with the group treasury policy. Group treasury reports on the interest rate profile, in particular that of the holding companies, to the group treasury, board, audit and risk committees on a regular basis.

Where appropriate, the group uses interest rate derivatives and other suitable hedging tools as a way to manage interest rate risk. The group does not apply hedge accounting to these derivatives.

Profile

At the reporting date the interest rate profile of the group’s interest-bearing financial instruments was:

Sensitivity analysis

The group has used a sensitivity analysis technique that measures the estimated change to profit or loss of an instantaneous increase or decrease of 1% (100 basis points) in market interest rates, from the rate applicable at 31 December, for each class of financial instrument with all other variables remaining constant. This analysis is for illustrative purposes only, as in practice market rates rarely change in isolation.

The group is mainly exposed to fluctuations in the following market interest rates: JIBAR, LIBOR, NIBOR, prime, EURIBOR and money market rates. Changes in market interest rates affect the interest income or expense of floating rate financial instruments.

A change in the above market interest rates at the reporting date would have increased/(decreased) profit before tax by the amounts shown below.

The analysis has been performed on the basis of the change occurring at the start of the reporting period and assumes that all other variables, in particular foreign currency rates, remain constant. The analysis is performed on the same basis as was used for 2016.

Currency risk

Currency risk is the exposure to exchange rate fluctuations that have an impact on cash flows and financing activities.

Currency risk arises on recognised financial assets and liabilities which are denominated in a currency that is not the entity’s functional currency. The group aims to maintain its foreign currency exposure within internally determined parameters, however, this depends on the market conditions in the geographies where the group operates. Group treasury reports on the status of foreign currency positions or derivatives to the group treasury committee on a regular basis.

Where possible, entities in the group use forward contracts to hedge their actual exposure to foreign currency. Refer to note 7.5 for the group’s outstanding foreign exchange contracts.

Sensitivity analysis

The group has used a sensitivity analysis technique that measures the estimated change to profit or loss and to equity, of an instantaneous 10% strengthening or weakening in the rand against all other currencies, from the rate applicable at 31 December, for each class of financial instrument with all other variables remaining constant. This analysis is for illustrative purposes only, as in practice, market rates rarely change in isolation.

The group is mainly exposed to fluctuations in foreign exchange rates in respect of the US dollar, euro and Iranian rial. This analysis considers the impact of changes in foreign exchange rates on profit or loss and equity.

The analysis excludes foreign exchange translation differences resulting from the translation of group entities that have functional currencies different from the presentation currency, into the group’s presentation currency, which are recognised in the foreign currency translation reserve.

The analysis has been performed on the basis of the change occurring at the start of the reporting period and assumes that all other variables, in particular interest rates, remain constant.

The group has changed the presentation to indicate the impact of the foreign exchange exposure on both profit or loss before tax and equity. Intercompany balances that are denominated in a currency other than the functional currency of the entity are reflected as either impacting profit or loss before tax, or equity in the case of loans that are not repayable in the foreseeable future.

A change in the foreign exchange rates to which the group is exposed at the reporting date would have increased/(decreased) profit before tax or equity by the amounts shown below.

Price risk

The group is exposed to equity price risk, which arises from available-for-sale investments (see note 7.2).

Refer to note 7.1.3 for disclosure of the sensitivity of the fair values of the investments to a change in the inputs used to determine their fair values. Other comprehensive income (before tax) will be affected by the amounts disclosed in respect of these investments in note 7.1.3.

Capital management

The group’s policy is to borrow using a mixture of long-term and short-term borrowing facilities to meet anticipated funding requirements. Borrowings are managed within the group’s established debt:equity ratios. The group seeks to maximise borrowings at an operating company level, on a non-recourse basis, within an acceptable level of debt for the maturity of the local company.

Management regularly monitors and reviews net debt:EBITDA, and net interest:EBITDA ratios.

Under the terms of the major borrowing facilities, the group is required to comply with financial covenants relating to net debt:EBITDA and net interest:EBITDA. The group has complied with all externally imposed covenants during the current and prior year.

The group’s net debt:EBITDA, net debt:equity and net interest:EBITDA at the end of the year are set out below. Net debt is defined as borrowings and bank overdrafts less cash and cash equivalents, restricted cash and current investments (excluding investments in cell captives). Equity approximates share capital and reserves. Net interest comprises finance costs less finance income and EBITDA is defined as earnings before interest (which includes gains and losses on foreign exchange transactions), tax, depreciation and amortisation and is also presented before recognising the following items:

• Impairment of goodwill.
• Loss in derecognition of long-term loan receivable.
• Net monetary gain resulting from the application of hyperinflation.
• Share of results of associates and joint ventures after tax.